Psychology Is Playing An Even Bigger Role Than Normal In The Market

Denise Shull is President of The ReThink Group, a consultancy providing advanced market, risk and behavioral intelligence. She holds a Master’s degree in Neuropsychology from The University of Chicago.

Traders say "the market takes the stairs up and the elevator down." CFAs say "show me the fundamentals." And Carl Icahn just says (well yells actually) "everyone else is wrong."

The truth is when the market, or even a given stock, is very near to its all-time highs, psychology plays an even bigger role than normal. The traditional analysts look for financial projections that indicate why equities should be trading for more, the economists look to things like the overall rate of growth of the economy and the technical analysts look at the old highs as impenetrable walls of resistance.

Research however shows that those who think of the market like a poker game – you are really betting against other player’s perceptions or intended perceptions – are better at predicting price action. Therefore, no matter how much you think the latest GDP numbers mean we can’t make it to new highs, think again.

Ask yourself – at these levels, who is in financial pain? Is it the guys who have been betting long or those who are short? As always, the ‘who is in more pain?’ question give huge insight into where the prices are likely to go.

Near new highs – or worse, AT new highs, means that everyone who is long is sitting pretty. They feel no pain. Particularly once an index or a stock makes it over and old high, it is smooth sailing with NO storm on the horizon. This means that the only force working against higher prices is those who believe that the underlying fundamentals don’t support the highs.

Unfortunately, as history shows, those beliefs are no match for the short squeeze overtaking those who thought that between the government, hurricanes, Europe, currency devaluations and a myriad of other depressing economic thoughts, there would be no way anyone would seriously invest in this market.

Near or above new highs you have three psychological forces – all arguing for higher prices.

Those already long have nothing to lose and are happy to watch their values increase.

Those who are short will stop the pain and buy – sooner or later.

Lots of people who haven’t been sure will start to feel the pain of regret – the coulda, woulda, shoulda – and their inclination will also to be to buy.

This doesn’t leave much firepower behind the sellers.

In other words, at new highs, rationales other than what is the other guy thinking, have very little market moving power. Those who expect prices to make sense outside of the psychological backdrop frequently find themselves disappointed.